Euro-zone GDP: Time to pop the champagne?

It’s happened. The euro zone has finally emerged from recession after struggling with six quarters of negative growth — the longest recession in the currency bloc’s history.

The joyous news came out at exactly 11 a.m. Frankfurt time on Wednesday when Eurostat, the statistics office of the European Union, released its flash estimate for second-quarter GDP in the euro zone, showing the economy expanded by 0.3%.

Repeat: Expanded. Not that same old contraction talk we’ve been going through over the past year and a half.

“We’ve said since the end of last year that the second quarter would be a quarter of transition. There’s still a long way to go, but now we have entered a phase with more positive growth,” says James Ashley, senior economist at RBC Capital Markets.

“Some of the macro headwinds have started to abate. Business confidence has improved, and that has supported investment. Inflation has slowed down, which helps household consumption, and the external environment such as the export markets has improved. The fiscal headwinds have also dropped a bit,” he adds.

“It’s not a story of great resurgence, but there are a number of reasons to be more positive.”

But how will markets take this? The initial reaction from the Stoxx Europe 600 index
/quotes/zigman/2380150XX:SXXP was barely noticeable, but the benchmark has now crept a little higher to post a 0.2% gain. The euro
/quotes/zigman/4867933/sampledEURUSD was trading lower compared with most major currencies, and was down to $1.3244 from $1.3259 late Tuesday. Not the response you’d expect if someone told you an 18-month nightmare was over.

And let’s look closer at Spain. Fears that the country — the euro zone’s fourth-largest economy — would ask for a bailout last year sent the sovereign benchmark 10-year bond-yield above the 7% level, making it extremely hard for businesses to borrow money. The yield is now relatively stable below 5%, but that doesn’t mean the country has escaped the crisis. The unemployment stubbornly stays above 25% — a level Spain will have to deal with for at least the next five years, according to a forecast for by the International Monetary Fund.

“The Spanish crisis is not over at all … The crisis will come back and rattle the markets at some point,” says Predrag Dukic, senior equity sales trader at CM Capital Markets in Madrid.

“Our debt is significantly above any targets and is unsustainable; we have continued high unemployment; the banking sector has not been sorted out yet; and the housing market has not really found its floor yet. [The housing market] will still fall another 20-25%, and the housing market was the trigger of this crisis, so there will be no end to crisis before that’s solved,” he notes.

A key problem for the broader euro zone is that output is struggling to find its way back to full speed. The so-called output gap — how much the combined countries’ economy is producing compared with how much it could produce — could take years to close, according to Ashley.

“Generally, for the euro zone, most people say the potential growth rate is somewhere around 1.5%, and it’s not until after you get more growth than that, will you start to close the output gap,” he says. “I don’t think we’ll be fully closing the output gap until towards the end of this decade.”

So for now, tempting as it may be, it might be better to keep the champagne on ice and pop the cork only when the euro zone is into a more sustainable recovery.

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